6 Earnings-Surprise Stocks for Your Portfolio - 13434 views

BALTIMORE (Stockpickr) -- It’s earnings season, which means that the stakes are raised for the next six weeks or so, as a slew of significant corporate earnings results get released to the public. Earnings are a big deal for any investor: After all, good earnings can be the catalyst for monumental moves in stocks -- and poor numbers can trigger double-digit sell-offs just as easily.

It all comes down to earnings surprise.

Simply put, an earnings surprise is when a company exceeds or falls short of the market’s expectations for its results. So to be fair, it’s not just strong earnings that spur a buying frenzy in a stock; instead, you need to find stocks with stronger earnings than the market had already priced in. Today, we’re going to attempt to spot those stocks ahead of time.

To do that, we’re looking at the S&P 500’s perennial outperformers -- stocks that have a history of material positive earnings surprise in the last several years. Not only do they have a higher statistical likelihood of being underrated by Wall Street, but I think that these names are also much more likely to beat estimates this quarter given the subdued valuations we’re seeing in 2011.

2011 has already been a fairly strong year for oil and gas supermajor Exxon Mobil (XOM). Shares of the company have rallied more than 14% year-to-date, besting the S&P by almost 9% on the heels of prolonged triple-digit oil prices. With earnings scheduled for next Thursday, this stock could make an excellent earnings surprise play.

Part of that comes from the fact that Wall Street has proven unable to accurately predict Exxon’s earnings. Over the past five years, XOM has bested Wall Street’s earnings expectations nearly two-thirds of the time -- and it’s beaten sales predictions three-quarters of the time. Those sales surprises are very material too -- average surprise rings in at 155.2%.

Low costs should be one of the biggest elements of success for Exxon this quarter. Because the firm already sports strength on the demand side of the equation as well as comparatively low costs at its oil and gas-producing assets, the company’s margins should continue to ring in strong this quarter. If an earnings beat comes with a dividend increase, shares could seriously appreciate next week.

Discount brokerage firm E*Trade Financial (ETFC) isn’t an earnings surprise play for the faint of heart. This stock fell into significant financial distress during the height of the recession as attempts to increase returns backfired in tougher economic times. But as the stock starts to shore up its business once again, investors could benefit from increased fundamental performance.

E*Trade expanded its operations during the boom, shifting its focus from discount brokerage to a more-capital intensive integrated banking model. While the move provided profitability when times were good, it left E*Trade with a balance sheet riddled with risky, unattractive assets when the bottom fell out of the housing market. Since then, E*Trade has returned to its core brokerage business, opting to court more revenue-intensive traders as it restructured its heavy debt load.

From an earnings consistency standpoint, this stock isn’t a high-quality name. Even so, Wall Street has known that for a while, leaving much of its discontent priced into shares right now. With average sales surprise of 136.1%, E*Trade could impress investors when it announced its numbers tonight after the bell. Still, consider this pre-earnings buy as speculative as they get.

Shares are up considerably today on news that major
investor Citadel LLC wants E*Trade management to consider a possible sale of
the company. That upward sentiment swing could play well after the bell.

On the other end of the spectrum is Berkshire Hathaway (BRK.A, BRK.B). Headed by Warren Buffett, this $188 billion conglomerate is the prototypical blue-chip stock. Berkshire owns a wide bevy of businesses, from GEICO Insurance to Netjets to apparel names such as Fruit of the Loom and Acme Boots.

Berkshire’s diversified operations mean that the company is less susceptible to more contained economic hiccups -- still, at its core, Berkshire Hathaway is a financial firm, and investors shouldn’t discount the stock’s exposure to more severe swings in interest rates or insurance losses.

Even though this stock has long been a Wall Street darling, it still has a history of besting analysts’ rosy expectations. Over the past 19 quarters, Berkshire has posted positive earnings surprise 13 times -- on average, beating estimates by double-digits.

Berkshire should report its second quarter 2011 numbers by the first week of August.

Philip Morris International

Overseas tobacco giant Philip Morris International (PM) is another name that’s shown solid performance in 2011 -- shares have rallied more than 17% so far this year. The company weighs in as the world’s second-largest tobacco company, with popular cigarette brands such as Marlboro, L&M, and Parliament flying the firm’s corporate flag. Financially, Philip Morris International has been performing at a high level in recent years, thanks largely to a major shift in demographics to the emerging markets.

While saturated markets in Western Europe offer few avenues for growth right now, less developed cigarette markets like China, Africa, and Eastern Europe do still have upside. In the cigarette business, brand is still a crucial element of any firm’s strategy, and because PM lays claim to such a powerful portfolio of names, the company is able to command a premium price and enjoy strong consumer stickiness even in less affluent markets.

Foreign currency risk is one of the biggest challenges to consistent earnings estimates for this stock. Still, a weak dollar has previously acted in PM’s favor, generating average sales surprise of 11.5% in the last five years. Watch for earnings tomorrow before the market opens.

Best-in-breed automaker Ford (F) may be one of the best examples of what a positive earnings surprise can do for a company that’s been on the wrong side of investor sentiment for too long. Ford shares rallied nearly 20% on outsized earnings numbers last October, and earnings on July 26 could give investors more of the same after a six-month selloff.

Ford has made significant strides toward improving its quality in the last few years -- not only the quality of its earnings but also the quality of its cars. Recent initial quality awards are finally curbing the notion that American cars can’t compete with foreign rivals from a quality and efficiency standpoint. And Ford is benefiting immensely from a sales standpoint.

In 2009, Ford’s persistence paid off, and the firm was able to record its first profit in years -- a profit that more than doubled last year. The firm has beaten analyst expectations by an average of 19.3% in the last five years, quite an accomplishment when you consider the fact that those years include pre-turnaround performance. This stock should be a solid performer this earnings season.

First Solar (FSLR) is a giant in the solar business, an industry that’s admittedly fallen upon hard times in the last few quarters. Even though shares have fallen more than 25% since its February peak, bearish analyst expectations could yield profits for investors if this name is able to produce a “less worse” quarter.

Right now, the consensus estimate for First Solar is 92 cents per share -- half of the EPS number that the company generated a year ago. While that muted estimate is based on diminished demand, and absurd competition, Wall Street may have overcompensated for market conditions.

First Solar is still the cost leader in the solar business, something that’s becoming all the more valuable as silicon prices increase input costs for all players. The company’s size also plays in its favor -- while other names in this capital-intensive industry are leveraged to the hilt, FSLR’s league leader status has enabled the company to build out an attractive balance sheet.

Earnings surprise has traditionally been outsized at First Solar -- the company’s EPS have historically bested estimates by 41.6% since going public. Investors should keep an eye on First Solar’s earnings call, expected to take place next week.

At the time of publication, author had no positions in stocks mentioned.

Jonas Elmerraji, based out of Baltimore, is the editor and portfolio manager of the Rhino Stock Report, a free investment advisory that returned 15% in 2008. He is a contributor to numerous financial outlets, including Forbes and Investopedia, and has been featured in Investor's Business Daily, in Consumer's Digest and on MSNBC.com.